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India may be known more for BPO than manufacturing, but the subcontinent's factories are roaring into life.
M. Mahanama, CFO Asia
July 2, 2008
Bharat Doshi, finance chief of India's US$6.2 billion Mahindra Group, is ever grateful he was only 42 years old in 1991. Back then, he was executive assistant to the managing director of Mahindra & Mahindra (M&M), the automotive arm of the Mahindra Group. As such, he spent much of his time in Delhi's labyrinthine "Licence Raj," trying to persuade bureaucrats to increase the number of tractors and off-road vehicles his company was allowed to make each year.
Then came India's liberalization in 1991. Reforms shifted the country from a planned economy to a market-based system; the legislature hacked away at stifling regulations; and India opened its borders to international trade. "My boss at the time was a brilliant man, but he spent all his life bogged down in getting approvals," says Doshi with a sigh. "At least for me it was only half my life. Since 1991, we have had the freedom to invest as we want, to embrace new technology, to set up collaborations and partnerships, to start making new types of products and to respond to the market. The change has been incredible."
It's also been tough, not just for M&M, but for all manufacturers in India. As Doshi recalls, "The scrapping of licensing and the introduction of competition — both with domestic players and foreign ones — was a complete shock." By 1993, for example, Japanese car-maker Suzuki was churning out 122,000 vehicles a year in India with a workforce of 4,000. Mahindra, by contrast, was producing 73,000 vehicles with a staff of 17,000.
Today, after years of restructuring and productivity improvements, Mahindra is not only growing rapidly — its revenue rose 37 percent last year — but is also expanding globally. Exports of tractors, light trucks, and sport utility vehicles grew 34 percent last year to nearly 21,000 units.
In many ways, M&M's recent transformation embodies the long journey of India's entire manufacturing sector. Decades of socialism, closed borders, and self-sufficiency starved firms of investment and opportunity. Now freed from these shackles and with the pain of restructuring behind them, India's manufacturers are emerging with a vengeance. Many are now world leaders in productivity — a remarkable change, considering how staggeringly uncompetitive they were in the early 1990s.
Take Tata Steel, part of India's Tata Group. During the decade between 1995 and 2005, Tata Steel halved its workforce, from 75,000 to 40,000, and doubled its output, from 2.5 million to 5 million metric tons of steel a year. In 1995, the company consumed 4.5 tons of raw material to produce 1 ton of steel; today it uses just 3 tons of raw material. In June 2005, World Steel Dynamics, a U.S.-based industry research group, gave Tata Steel ten out of ten for its operating costs in a survey and named it "the best steel company in the world."
Finance on the Frontline
Along the way, finance at these companies has been a driving force in key areas. Cost control is one. "For CFOs in Indian manufacturing, we don't call for price increases. We spend 70 percent of our time hunting down ways to cut costs," says K. Sridharan, CFO of Ashok Leyland, a US$1.7 billion maker of buses, trucks, and diesel engines. "Cost competitiveness is absolutely key. It's suicide to build new capacity on anything but a foundation of super-efficiency."
That super-efficiency includes a system Sridharan and his team developed to pare costs to the bone. Starting with the simple observation that cost divided by output yields a product's per unit cost, Sridharan and his team have used this equation for a very granular view of its costs. "Using this philosophy to blow up our cost drivers and understand them is the foundation of our competitiveness," he explains.
The philosophy is also a key way to help the company cope with the escalating material prices hitting manufacturers around the world, spurring it to find new ways to keep purchasing costs low. Along with joining forces with other local car makers to cut bulk deals with suppliers, it's also scouring the globe to source components in cheaper markets, including China. As Sridharan recently told The Times of India, Ashok Leyland has been steadily increasing its purchases of components in China over recent years, now totalling a few million dollars.
And Ashok Leyland's cost-consciousness stretches beyond its own factories. In 2006, when one of its suppliers began struggling to produce the fuel tanks used in its trucks, Ashok Leyland weighed up whether it should simply throw money at the problem by launching a capex program to help the supplier. Instead, the vehicle maker decided to send its supply chain team onto the vendor's shop floor, and subsequently identified a series of fast, incremental measures it could take to improve plant capacity. One measure involved tweaking processes that reduced machine downtime; another was to change remuneration so that it was linked to productivity. Machine downtime tumbled, as did maintenance costs. What's more, individual productivity improved 40 percent from the previous year and production doubled to 65 tanks a day, enabling Ashok Leyland to increase its vehicle roll-out by 45 percent.
Having achieved new levels of efficiency, Ashok Leyland is now confidently stepping onto the global stage. Exports are growing and the firm is making acquisitions overseas — including a 2006 deal in the Czech Republic. It has taken this a step further with an arguably bolder move — its planned acquisition of French car-parts company Valeo, announced earlier this year. "Our system for identifying and improving our cost drivers underpins our M&A strategy because we can see clearly how we might add value to the manufacturing processes at a target company," explains Sridharan.
Many other manufacturers have followed a similar journey. At M&M, for example, Doshi — CFO since 1992 — has instilled a new culture that emphasizes production driven by market demand rather than quotas decided by the country's plethora of labor unions. "In the early days, we could shut off the electricity in our factories half-way through a night shift and nobody would complain," he recalls. "The workers had built their quota of engines for the night and were all sleeping."
Beyond shop floors, however, CFOs cite a more vexing challenge that's largely outside of their control. According to a recent report from the International Monetary Fund, the country's overstretched infrastructure is shaving one percentage point off its GDP growth every year. Ports and airports are straining at capacity, roads are congested, and electricity supply is patchy and falls well short of demand. On average, companies report power outages 85 days a year.
Such constraints, of course, create real headaches for manufacturers. At M&M, for example, Doshi tells how all factories have to build standby diesel generators to make up for power shortfalls. That raises both investment cost and the cost of diesel-generated power, which is 11 rupees (26 US cents) per unit compared with 3.7 rupees (9 US cents) for a unit of grid-connected power. Equally, because ports and roads are so stretched, M&M's suppliers are often forced to keep as much as a month's inventory on hand to make sure that production lines don't grind to a halt.
Another oft-cited challenge involves workforce management. Relative to other emerging economies in the region, labor productivity in India has historically been low, partly because of inflexible laws that make it tough to lay off workers or hire part-time workers to meet seasonal demand. Furthermore, unions are particularly strong in India, making it relatively easy for workers to vent their displeasure about company decisions and take industrial action in a way that hasn't been possible in countries like China.
"The rigid labor policies of the government get in the way of our cost competitiveness," laments Ashok Leyland's Sridharan. "We have a five-year rolling plan and at no point in that plan can I assume any staff redundancies. In all our initiatives, we have to build our strategies around this constraint."
The silver lining is that many Indian firms have been growing at such a pace that excess workers have been easily re-absorbed into other parts of their companies. While unions rail against workers being forced to accept different jobs than what they initially signed on for, such complaints are much less prevalent today than they were in the 1990s, when Indian manufacturing went through its most extensive restructuring.
A further challenge — among CFOs of both local and foreign manufacturers — has been the tax environment. The country's complex transfer-pricing regime, in particular, draws heavy fire from Coen Reuvers, CFO of Philips India, part of the US$42 billion Dutch electronics and lighting group that set up its first factory in India some 70 years ago. As he explains, "Often the authorities initially assume that the local profit on inter-company exports is four or five times higher than the corporate global assessment. And when the tax authorities contest corporate tax assessments in court — which they do frequently — the cases take years to resolve."
Then there is the multiplicity of indirect taxes levelled by both the federal and state governments. "If you're moving goods across the country, sales taxes can be repeatedly charged by each individual state the goods pass through," says Reuvers. "You have to be smart about your logistics, using a network of depots to reduce the tax burden."
Add up all these constraints and India should seem less than enticing for manufacturers. And yet, manufacturing output is climbing and investment in new production capacity is gathering pace, from foreign and local players alike. Similarly, exports are growing, at an average annual rate of 19.2 percent since 2000.
The biggest spur has been India's dynamic economy. With growth that has averaged more than 8 percent for the past five years, per capita income levels are climbing and stimulating domestic demand for manufactured goods. Sales of passenger cars, for example, have doubled in the past six years to 1.1 million in 2007. Meanwhile, India has become a hot-house of ideas for taking products created in the West and re-tooling them for emerging markets, where consumers have much lower disposable incomes and conditions — such as India's poor-quality roads — are vastly different from developed markets.
Manufacturers' engineers are also developing products at a lower cost than in the West. After Renault and M&M announced a joint venture a year ago to manufacture the Logan car for the Indian market, Carlos Ghosn, CEO of the French car maker, enthusiastically announced that engineers at Renault's Indian partner figured out how to reduce the new model's production cost by 15 percent.
According to Reuvers, this process — known as "frugal engineering" — is a prime attraction for manufacturers wanting to get a foothold in developing countries. "Emerging markets are where the growth is today and we need to have products that are suitable for these markets," he explains. "India is a wonderful place to develop these products." For its part, Philips has been acquiring healthcare companies that can design and build medical equipment at a cost suitable for emerging markets.
Meanwhile, the deepening supplier base for many industries in India is adding significant support for manufacturers aiming to serve the growing local market. ABB, the US$45 billion Swiss-Swedish engineering group, has 14 factories in India making products for the power sector, and motors and robots for industrial automation. ABB's policy is to manufacture locally all over the world, and in India it makes 90 percent of the firm's 1,000 or so products on the ground. For 10 of those product lines, India is a "global center," taking the lead in design and manufacture, and exporting to other countries. As K. Rajagopal, CFO of ABB's US$1 billion Indian operation, sees it, manufacturing in India is benefiting from a local supplier base that "has been improving gradually for at least 10 years now, but in the last five years we've seen a real surge."
And because the supply networks feeding manufacturers are improving, new industrial clusters are developing. Take Sriperumbudur, a town that's part of an emerging manufacturing corridor connecting Chennai with Bangalore. The likes of Nokia, Samsung, Motorola, Dell, and Flextronics are all investing heavily there, creating an ever more integrated ecosystem for electronics manufacturing. And it's not just technology companies. Ford, BMW, and Hyundai are also expanding their car manufacturing around Sriperumbudur, as are French glass-maker Saint Gobain and U.S. ball bearing manufacturer Timken.
Then there are the burgeoning special economic zones being developed right across the country, offering tax breaks to exporters, not to mention pockets of first-rate power, roads, and other infrastructure. The proportion of India's exports originating from SEZs has more than doubled today from nearly 5 percent in 2005, when the government formalized its SEZ policy. (See "Moving to the SEZs" at the end of this article.)
Adding more interest to India's manufacturing story, the Indian government is starting to address many of the country's traditional problems. The government's current five-year plan, which runs to 2012, calls for US$500 billion of infrastructure spending, 70 percent of which it expects to come from the private sector. To that end, it has rolled out more robust and innovative policies governing public-private partnerships. The response has been impressive. In 2007, funds investing in Indian infrastructure raised US$4.7 billion of capital compared with US$600 million in 2006.
And the list of projects being taken on by the private sector grows longer by the day. In June, Vedanta, a U.K. mining and metals group, announced plans to invest US$10 billion over the next four years in a network of power plants with a generating capacity of 10,000 megawatts. Danish shipping giant AP Moller Maersk is in the midst of expanding Pipavav, India's first private port.
Sridharan of Ashok Leyland believes Indian politicians have gained a new level of maturity by recognizing the importance of infrastructure development. "Policies are now surviving from one government to the next; we aren't seeing reverses," he notes. The speed of progress may slow down or speed up, but the direction is consistent. Equally, he adds, "India has begun to embrace a 'user pays' culture. In the past, everyone expected everything to be free — health, roads, education, power. Now there is much greater acceptance of paying for things like road tolls, which makes infrastructure development much more feasible. A lot of the developers are making very good money."
It all points to a promising future for manufacturing in India. And for Mahindra's Doshi, it makes for far more pleasant trips to the country's capital. "In the past, I visited Delhi to negotiate approvals. These days it's only ever to give lectures on how successful liberalization has been," he chuckles.
M. Mahanama is a frequent contributor to CFO Asia.
Chemicals and Car Parts
As India's economy powers ahead, some types of manufacturing in the country will fare better than others, predicts Ramesh Mangaleswaran, a partner at McKinsey in Mumbai and head of the consultancy's manufacturing practice in India. In this respect, he believes India's engineering and innovation skills are critical. "The firms doing really well in Indian manufacturing are those making products that are medium-volume, high-variety types of goods, which require a high degree of skill and engineering," such as specialty chemicals, pharmaceuticals, and car components, he says. "China, by contrast, has done very well in items where there are much larger volumes and less variety in the production."
But what will happen now that China has said it wants to move away from manufacturing low-end, low-value goods and target the same types of higher-value products that are doing so well in India? Mangaleswaran doesn't see a conflict. "For me it's not about China versus India," he says. "Both economies are growing rapidly and creating huge demand, so both will need strong manufacturing. And firms will want to diversify anyway by having production in both countries."
As for labor-intensive products, such as shoes, garments, plastic toys, and bicycles, he believes that India will succeed in building manufacturing for the domestic market in these areas but will struggle as a significant exporter. "My sense is that India has missed the boat for these types of goods," he says. Countries such as Bangladesh and Vietnam are more likely to be the natural inheritors of such industries as they move out of China. That said, for high-end garments that require greater skills, low production runs and extensive product variability, India may do well. — M.M.
A Say on Pay
India has become famous for its wage-inflation troubles — particularly in IT and software development. But, says Tulsi Tanti, CEO of Suzlon, a US$3.2 billion maker of wind turbines, labor costs in other parts of the economy aren't as troublesome. Wages in engineering and manufacturing haven't risen as much. "Talent is a constraint in India, and salaries are rising, but the investments being made in education today will alleviate the pressures in the medium-term," he predicts.
What's more, adds Tanti, because India graduates 400,000 engineers every year, and because they work more cheaply than their peers in the West, "The cost of innovation in India is cheaper than anywhere else."
K. Rajagopal, CFO of India for Swiss-Swedish company ABB, agrees that India's cost competitiveness has many years to run. "Salaries are rising, it is true," he concedes, "but wages are equal to just 6 percent of our revenues in India. In Europe, they're equal to 30 percent of revenues."
At India's automotive giant Mahindra & Mahindra, the firm's CFO, Bharat Doshi, recalls how, during a conversation with a foreign partner, his firm realized how inexpensively it had designed its new Scorpio jeep, launched in India in 2002. M&M had spent just one eleventh of what it would have cost to do it in the United States. M&M has since set up a business line where its engineers can be hired on an outsourced basis by other manufacturers. — M.M.